Earnings quality and stock returns

An exclusive focus on bottom-line income misses important information contained in accruals ( the difference between accounting earnings and cash flow) about the quality of earnings. Earnings increases that are accompanied by high accruals, suggesting low-quality earnings, are associated with poor future returns. We explore various hypotheses earnings manipulation, extrapolative biases about future growth, and under-reaction to changes in business conditions-to explain accruals' predictive power. Checks for robustness using withinindustry comparisons and data on U. K. stocks are also provided.